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Too soon to use policy tools to shore up economy: Carney

Bank of Canada governor Mark Carney says it is &quot;entirely premature&quot; to talk about implementing in this country the kinds of unorthodox policy tools the Federal Reserve Board is preparing to wield after the U.S. central bank cut its key interest rate this week to virtually zero.

Bank of Canada Governor Mark Carney said in a speech in Toronto, Dec. 17, 2008, the chartered banks’ failure to pass on the full impact of recent policy interest rate cuts is complicating the central bank’s efforts to boost lending. (STEVE RUSSELL / TORONTO STAR) | Order this photo

By Ann PerryBusiness Reporter

Thu., Dec. 18, 2008

Bank of Canada governor Mark Carney says it is "entirely premature" to talk about implementing in this country the kinds of unorthodox policy tools the Federal Reserve Board is preparing to wield after the U.S. central bank cut its key interest rate this week to virtually zero.

Reiterating that Canada has entered a recession that will persist into next year, Carney admitted in a noon-hour speech that the bank does "contingency planning" and has looked at these issues "for decades."

But he also said Canada's economy has "a number of fundamental strengths," including a functioning and well-capitalized financial system. While emphasizing that 2009 will be "a trying year," he suggested in his speech there is a light at the end of the tunnel, but said central bankers and government shouldn't let down their guard.

"It is sometimes hard to see the end of the crisis, but end it will," Carney said, urging better early-warning systems to detect future financial crises before they happen.

Last week, the Bank of Canada lowered its target for the overnight rate – the interest rate that financial institutions charge each other – by three-quarters of a percentage point to 1.5 per cent, the lowest level in half a century. The latest cut continued a string of sharp cuts that have seen the central bank's key rate drop from 4.5 per cent in the past year. The central bank will make its next rate announcement on Jan. 20.

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But as the global financial crisis deepens, the U.S. has already run out of rate-cutting room. On Tuesday, the Federal Reserve slashed its target for the overnight federal funds rate to a record low range of 0 to 0.25 per cent, down from 1 per cent. The move means the central bank effectively has largely exhausted traditional monetary policy tools, forcing it to consider unconventional – and largely untested – means of jump-starting the battered U.S. economy.

In an effort to bring down longer-term interest rates, the Federal Reserve suggested it was willing to keep rates low for an extended period, and said it will "employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability."

While Carney refused to speculate about the prospect of Canada's trend-setting rate going to zero, one of the country's big banks said yesterday that it could eventually fall as low as 0.5 per cent.

"And when the economy finally gets back into gear, given low inflation as a residual, we don't think that the Bank of Canada or the Fed (would) start tightening much before the second half of 2010," Warren Jestin, chief economist of the Bank of Nova Scotia, said yesterday during a conference call.

"The Bank of Canada may be a little earlier because economic conditions are a little better. But it is not going to be a huge difference between the two economies," Jestin said.

Carney said the fact that commercial banks sometimes do not pass on the full impact of the central bank's interest rate cuts "is a complication, but it is not insuperable." After last week's three-quarter point cut, the country's big banks dropped their prime rates by only half a percentage point.

Carney said the Bank of Canada would like to see a "one-to-one pass-through" of its rate moves, but added it is not entirely surprising that some banks don't move every time.

He said the central bank takes the cost of financing into account, and adjusts its policy rate based on what it thinks the net stimulus will be.

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